TY - JOUR AU - Koijen,Ralph S.J. AU - Lustig,Hanno AU - Nieuwerburgh,Stijn Van TI - The Cross-Section and Time-Series of Stock and Bond Returns JF - National Bureau of Economic Research Working Paper Series VL - No. 15688 PY - 2010 Y2 - January 2010 UR - http://www.nber.org/papers/w15688 L1 - http://www.nber.org/papers/w15688.pdf N1 - Author contact info: Ralph Koijen University of Chicago Booth School of Business 5807 South Woodlawn Avenue Chicago, IL 60637 Tel: 773/834-4199 E-Mail: ralph.koijen@chicagobooth.edu Hanno Lustig UCLA Anderson School of Management 110 Westwood Plaza, Suite C413 Los Angeles, CA 90095-1481 Tel: 310/825-1011 Fax: 310/825-9528 E-Mail: hlustig@anderson.ucla.edu Stijn Van Nieuwerburgh Stern School of Business New York University 44 W 4th Street, Suite 9-120 New York, NY 10012 Tel: 646/284-4141 Fax: 646/284-4141 E-Mail: svnieuwe@stern.nyu.edu AB - We propose an arbitrage-free stochastic discount factor (SDF) model that jointly prices the cross-section of returns on portfolios of stocks sorted on book-to-market dimension, the cross-section of government bonds sorted by maturity, the dynamics of bond yields, and time series variation in expected stock and bond returns. Its pricing factors are motivated by a decomposition of the pricing kernel into a permanent and a transitory component. Shocks to the transitory component govern the level of the term structure of interest rates and price the cross-section of bond returns. Shocks to the permanent component govern the dividend yield and price the average equity returns. Third, shocks to the relative contribution of the transitory component to the conditional variance of the SDF govern the Cochrane-Piazzesi (2005, CP) factor, a strong predictor of future bond returns. These shocks price the cross-section of book-to-market sorted stock portfolios. Because the CP factor is a strong predictor of economic activity one- to two-years ahead, positive shocks to CP signal improving economic conditions, leading to a positive price of risk. Value stocks are riskier and carry a return premium because they are more exposed to such shocks. ER -